NEW YORK–(BUSINESS WIRE)–Fitch Ratings has downgraded Nabors Industries, Ltd. (Nabors; NYSE: NBR) and its affiliate’s Long-term Issuer Default Rating (IDR) to ‘BBB-‘ from ‘BBB’. The Rating Outlook remains Negative.
The downgrade reflects Fitch’s lower and longer onshore rig recovery profile following the revision of Fitch’s oil & gas price assumptions downwards. This results in a weaker than previously expected U.S. Lower 48 (L48) and international drilling activity outlook that increases the forecasted leverage profile above Fitch’s through-the-cycle levels for a ‘BBB’ credit over the rating horizon. Fitch’s base case currently forecasts debt/EBITDA metrics will increase to approximately 3.4x and 4.8x in 2015 and 2016, respectively, from nearly 2.8x for the latest 12 months (LTM) as of Sept. 30, 2015.
Fitch anticipates Nabors will continue to take steps to protect quality through-the-cycle that limits gross debt additions and preserves liquidity including manage operating costs, balance capital spending with operating cash flow, and curb incremental shareholder activities. However, the Negative Outlook considers the effect that persistently low oil & gas prices could have on U.S. and international exploration and production (E&P) company capital budgets. This could result in a deeper and longer than forecast onshore drilling downcycle that causes the leverage profile to remain above our through-the-cycle levels for a ‘BBB-‘ credit.
Fitch’s base case forecasts U.S. activity will continue to contract in 2016 followed by a gradual, U-shaped rebound. This is consistent with the historical U.S. demand for onshore oilfield services mirroring, subject to a few month lag, oil & gas market price movements. The characteristics of shale (e.g., low well costs, short development period, high initial production rates) are also likely to result in a relatively quicker activity response to supportive prices offset by E&P companies’ ability to invest. This, in conjunction with Nabors’ AC-weighted U.S. rig fleet, should position the company favorably in a price recovery scenario. International should remain a resilient cash flow contributor, albeit at lower levels, over the near-term helping to mitigate the outsized cyclical effects on Nabors’ U.S. L48 fleet.
Approximately $3.7 billion of debt is affected by today’s rating action. A full list of rating actions follows at the end of this press release.
KEY RATING DRIVERS
Nabors’ ratings consider its operational and financial flexibility, favorable asset quality characteristics and global footprint, forecasted neutral-to-modestly positive free cash flow (FCF) and flat gross debt profile, and adequate liquidity position with subsequent ability to manage its leverage profile through the downcycle. These positive considerations are offset by the possibility of a prolonged onshore rig recovery, particularly in the U.S. L48, resulting in lower utilization rates and continued pricing pressure. Other factors include the potential for continued realization of production efficiencies and obsolescence risk for legacy rigs. Management’s willingness and ability to manage gross debt levels and, in the current hydrocarbon pricing environment, curtail shareholder activity will remain a key focus through-the-cycle.
MACRO WEAKNESS CONTINUES TO OUTWEIGH U.S. L48 ASSET QUALITY BENEFITS
U.S. L48 land rig counts (578 as of Jan. 29, 2015) have experienced price-induced declines of approximately 69% since the November 2014 peak. The U.S. L48 land rig count showed some signs of stabilization during the second and most of the third quarters, but has consistently fallen since late August a total of 31%. Nabors’ U.S. L48 fleet has experienced somewhat better utilization trends than the industry, at least through the first nine months of 2015, due to its favorable power type mix and contract backlog. However, the company’s U.S. L48 fleet will be increasingly exposed to lower spot pricing as term contracts (roughly two-thirds contracted as of Sept. 30, 2015) roll-off. Management has previously indicated that 40 rigs will be under contract to begin 2016 with 20 of those rig contracts expiring during the year.
The company’s U.S. L48 land rig fleet is weighted towards AC drive rigs at 172, or about 20% of total AC-drive U.S. land rigs. Further, the company’s higher specification PACE-X rigs (49 were planned by year-end 2015) have been exhibiting strong performance. These rigs are accretive to both Nabors via premium day rates/margins and E&P companies via efficiency gains. Fitch continues to believe that Nabors’ U.S.-based, non-AC-drive rigs (85 as of Sept. 30, 2015; 12% utilization), particularly those not working, continue to be at heightened risk of obsolescence in the current market environment despite some retirements during 2015.
Fitch currently expects U.S. L48 drilling activity to begin to show signs of stabilization during the second half of 2016. This is a revision from Fitch’s previous estimate of the first half of 2016 due to Fitch’s updated oil & gas price assumptions. Fitch is also recalibrating its N.A. E&P capital spending estimate to the top end of Fitch’s previous estimate to 30%-plus from 20%-30% with early guidance suggesting even deeper cutbacks.
Rig pricing and margin pressure should be somewhat alleviated by the asset quality of the company’s existing fleet, as well as the 17 newbuild PACE-X rigs that have been and were expected to be deployed during 2015. Nevertheless, the downcycle has negatively influenced spot pricing for high-spec AC rigs with spot dayrates estimated to be $16,500-$17,500 (down 30%-plus from peak levels) compared to daily cash costs of $12,500-$13,500. Further, Fitch continues to anticipate that the company’s legacy rig fleet will continue to experience pricing – estimated to be at or near breakeven levels – and utilization headwinds with additional legacy fleet rationalization activity possible.
RESILIENCE OF INTERNATIONAL ACTIVITY TO CONTINUE TO PROVIDE COUNTERBALANCE
Nabors’ international drilling business has exhibited strong growth the past several years. The company has a strong presence in Saudi Arabia and Argentina, as well as other principally Middle Eastern and Latin American countries. The international land drilling market has exhibited a much more resilient rig count profile – down 19% based on Dec. 2015 Baker Hughes’ international rotary rig count from 2014 peak levels – with the Middle East (3% reduction) experiencing the least downward pressure.
Notably, Saudi Arabia has been generally increasing its rig count since the beginning of 2014 (up over 50%), which is consistent with the country’s reported strategy to preserve and potentially grow its global oil market share. Argentina, meanwhile, has generally maintained its drilling activity flat through-the-cycle, but rig counts exhibited declining trends during the fourth quarter of 2015. Argentina’s rig count exited the year at 90 vs. a 106 average during the first three quarters of 2015. This is consistent with management’s recent commentary about market stress in Argentina and in Latin America more broadly. Nabors’ Canadian drilling operations is also experiencing considerable weakness (27% utilization; 63 Canadian rigs as of Sept. 30, 2015) with Fitch anticipating utilization to generally remain at these weaker levels over the medium term.
Fitch expects the company’s international operations to show more resilience than the U.S. L48 supported by its exposure to less price sensitive markets and existing multi-year rig contracts, as well as the recent and pending delivery of five newbuild/upgraded rigs. Nevertheless, some international markets will be challenged in the current oil & gas price environment leading to some downward pressure on rig years.
Fitch highlights that the increase in international drilling’s contributions to revenues (55% for the first nine months of 2015 vs. 39% for the same period in 2014) and cash flows (Fitch estimates a roughly 2.5x margin difference in international relative to U.S. L48 due to depressed U.S. L48 pricing vs. the historical 1.5x-1.75x) heightens Nabors’ through-the-cycle rating reliance on the international drilling segment’s performance.
FORECAST BALANCED FCF PROFILE, METRICS WIDEN DUE TO WEAK, PRICE-INDUCED DRILLING ENVIRONMENT
Fitch’s base case projects that Nabors will be approximately $200 million FCF negative, including dividends, in 2015 followed by a relatively balanced FCF profile in 2016. The 2016 FCF estimate considers corporate and field operating cost savings, a capital program generally sized to operating cash flows, and some working capital improvement gains. The Fitch base case results in debt/EBITDA of approximately 3.4x and 4.8x in 2015 and 2016, respectively, followed by a steadily improving leverage profile thereafter.
Given the current market environment, Fitch has placed increasing weight on its stress case scenarios that currently forecast that debt/EBITDA could exceed 6x – 7x in 2016 with FCF remaining neutral-to-positive given cost saving efforts, capital spending flexibility, and working capital improvements.
Another consideration is the potential for a dividend reduction that could save approximately an additional $70 million in annual cash outflows. Fitch believes, however, that prices and onshore demand are likely to recover in the out years as large capex cuts made across the industry to date begin to result in meaningful supply reductions.
Fitch’s key assumptions within the rating cases for Nabors include:
Fitch Base Case:
–WTI oil price that trends up from $45/barrel in 2016 to a longer-term price of $65/barrel;
–Henry Hub gas price that trends up from $2.50/mcf in 2016 to a longer-term price of $3.25/mcf;
–Continued weakness in U.S. rig counts with signs of stabilization during the second half of 2016 followed by a modest uptick in demand;
–International drilling results are projected to be more resilient given the relatively better international rig count profile, particularly in Nabors’ largest international markets – Saudi Arabia and Argentina;
–Completion & Production Services results are considered in 1Q15 with no cash flows/dividends assumed post-merger;
–Capital expenditures of roughly $900 million in 2015, consistent with company guidance, followed by a relatively balanced capital spending profile over the medium term;
–Quarterly dividend remains $0.06/share with no additional shareholder actions contemplated near term;
–C&J Energy Services (NYSE: CJES) equity stake is assumed to be retained over the near term.
Fitch Stress Case makes the following key adjustments to the Fitch Base Case:
–WTI oil price that trends up from $35/barrel in 2016 to a longer-term price of $45/barrel;
–Henry Hub gas price that trends up from $2.25/mcf in 2016 to a longer-term price of $2.75/mcf;
–Lower and longer U.S. and international rig count profile;
–Capital expenditures reach an assumed maintenance capital spend level of approximately $300 million in some of the out years.
Positive: No positive rating actions are currently contemplated in the near-term given the weak oilfield services outlook. However, future developments that may, individually or collectively, lead to a positive rating action include:
For an upgrade to ‘BBB’:
–Demonstrated commitment by management to lower gross debt levels;
–Mid-cycle debt/EBITDA below 2.5x on a sustained basis.
To resolve the Negative Outlook at ‘BBB-‘:
–Demonstrated ability to manage FCF resulting in no material additions to gross debt levels;
–Retention of nearly full availability under the $2.25 billion revolver balanced by borrowings to repay the 2016 senior notes maturity and invest in near-term cash flow supportive spending;
–Heightened rig utilization and average day rates/margins signalling an improvement in market conditions;
–Mid-cycle debt/EBITDA of 3.0x – 3.25x on a sustained basis.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
–Failure to manage FCF that significantly reduces liquidity and increases gross debt levels;
–Material, sustained declines in rig utilization and average day rates/margins indicating a structural deterioration in market conditions;
–Shareholder friendly actions that are inconsistent with the capital structure and expected cash flow profile;
–Mid-cycle debt/EBITDA 3.5x – 3.75x on a sustained basis.
Fitch anticipates resolving the Rating Outlook within 12-18 months with rating actions closely linked to the resiliency of international drilling activity through-the-cycle and the onshore rig outlook. Given Fitch’s view that U.S. L48 activity is likely to respond relatively quicker to supportive prices, Fitch would look for meaningful production declines or inventory drawdowns as supportive onshore rig recovery signals.
ADEQUATE LIQUIDITY POSITION
Cash, cash equivalents, and short-term investments (mainly comprised of equity securities) totalled $277 million as of Sept. 30, 2015. Supplemental sources of liquidity consist of the company’s $2.25 billion senior unsecured credit facility due July 2020 and commercial paper (CP) program. The company also has a $450 million accordion option that, subject to bank participation, can be exercised. As of Sept. 30, 2015, Nabors had, on a pro forma basis, approximately $2.2 billion available on its credit facility and associated CP paper program considering the use of the $325 million five-year unsecured term loan to pay down CP borrowings.
An additional source of liquidity is the company’s 53% ownership interest in CJES (valued at under $150 million as of Jan. 29, 2016). Fitch notes that the company’s six-month lockup period ended Sept. 24, 2015. Fitch anticipates the company will retain its equity stake over the medium term given its balanced FCF and adequate liquidity profiles. Further, retention of the company’s CJES position provides share price upside potential from a pick-up in market activity and realization of merger synergies.
LADDERED MATURITIES PROFILE
Nabors has a laddered maturities profile with $350 million, $930 million, $340 million, and $700 million of maturities in 2016, 2018, 2019, and 2020, respectively. These maturities represent the company’s 2.35% senior unsecured notes due September 2016, 6.15% senior unsecured notes due February 2018, 9.25% senior unsecured notes due January 2019, and 5.0% senior unsecured notes due September 2020. Additionally, the recently issued $325 million five-year term loan has a mandatory prepayment of $162.5 million in September 2018.
Financial covenants, as defined in the credit facility agreement, require Nabors to maintain a net debt-to-total capitalization ratio below 0.6x (Fitch estimate of 0.4x as of Sept. 30, 2015). The covenant, as defined in the credit agreement, does not have a non-cash asset impairment carve out. While the depressed oil & gas price environment could negatively impact stockholder’s equity, the estimated covenant headroom should alleviate the risk for any near-term covenant pressure. Other customary covenants across Nabors’ debt instruments consist of lien limitations, transaction restrictions, and change of control provisions.
MANAGEABLE OTHER LIABILITIES
Nabors’ defined benefit pension plan (assumed in a 1999 acquisition) was about $9.1 million underfunded, equal to a 72% funded status, at year-end 2014. All benefits under the plan were frozen and participants were fully vested prior to the acquisition – limiting future obligations. Fitch believes that the expected size of service costs and contributions is manageable. Other contingent obligations total nearly $1.3 billion on a multi-year, undiscounted basis as of Dec. 31, 2014. These obligations mainly consist of purchase commitments ($1.1 billion), pipeline minimum volume commitments ($84.6 million), minimum lease payments ($96.4 million), and minimum salary and bonus obligations ($19.1 million). Fitch does not consider the obligations as credit concerns, with the majority satisfied during 2015.
FULL LIST OF RATING ACTIONS
Nabors Industries, Ltd. (Bermuda)
–Long-term IDR to ‘BBB-‘ from ‘BBB’.
Nabors Industries, Inc. (Delaware)
–Long-term IDR to ‘BBB-‘ from ‘BBB’;
–Senior unsecured bank facility to ‘BBB-‘ from ‘BBB’;
–Senior unsecured notes to ‘BBB-‘ from ‘BBB’;
–Short-term IDR to ‘F3’ from ‘F2’;
–Commercial paper program to ‘F3’ from ‘F2’.
The Rating Outlook remains Negative.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Dodd-Frank Rating Information Disclosure Form